Meeting of the Global Minds

The United States has a C-grade retirement system. That is according to the 2011 Melbourne Mercer Global Pension Index, which rates 16 countries’ pension systems based on their adequacy, sustainability and integrity. The U.S. ranked 10th in the study released in October 2011, with the Netherlands coming in first, followed by Australia, Sweden, Switzerland, Canada, the U.K., Chile, Poland and Brazil. Only six countries ranked lower than the United States: Singapore, France, Germany, Japan, India and China.

Americans can take heart in the fact that Mercer did not grade any country’s retirement system as an A. What does that say? “That this is an extremely complex issue, and nobody has got it perfect,” says Deborah Ralston, director of the Melbourne-based Australian Centre for Financial Studies, which partnered on the index’s research. “Some countries have worked out the adequacy issue but not the sustainability issue, and others have worked out the sustainability issue but not the adequacy issue. The idea is to hold up a mirror to countries and say, ‘This is what could be achieved.’”

All Western economies have a powerful incentive to work on it, Ralston says: a rapidly aging population. Some countries with a history of generous social safety nets have overpromised benefits and need to make cutbacks. Some, like the United States, arguably need to do more collectively to ensure retirement adequacy, although American culture makes that challenging. “The U.S. is a more individualistic society,” says Keith Ambachtsheer, president of Toronto-based KPA Advisory Services Ltd., a strategic adviser to institutional investors around the world. “There is less of a tendency for people to sit in a room and say, collectively, ‘What can we do?’” The Mercer report does have five recommendations for the United States about how to improve.

1) Raising the minimum pension for low-income pensioners: The study’s many dimensions include looking at the minimum percent of the average wage that a single retiree receives in different countries, even if someone has no savings and no work history. “The level of a minimum pension in the U.S. system is a little bit lower than similar countries,” says Dr. David Knox, a Melbourne, Australia-based senior partner at Mercer. He cites Canada, Australia, France, the U.K., Sweden, and Switzerland as placing higher.

The United States has Supplemental Security Income (SSI), “but it is a very, very minimal benefit,” says Dallas Salisbury, president and CEO of the Washington-based Employee Benefit Research Institute. According to the Social Security website, in 2011, the highest monthly federal SSI payment totaled $674 for an individual and $1,011 for a couple. States may add additional money.

“We think it is feasible to provide a base pension on the order of 25% to 30% of the average wage,” Knox says, “and the American system provides about 18%.”

Canada has a flat-rate Old Age Security (OAS) that provides 8,000 Canadian dollars ($7,711) per year to all retirees 65 or older, and a Guaranteed Income Supplement (GIS) for those on the low-income end. “It basically doubles the annuity to CA$16,000 ($15,423)” annually for an individual, Ambachtsheer says, even if someone has not worked. Couples receive more.

Means-tested Social Security has challenges, however. The U.K. system, which currently includes a flat-rate basic pension and income-tested pension credit, could change soon. “The latest proposal, which has yet to be ratified, is that there should be a single, flat-rate pension,” says Bob Scott, a London-based partner at pension consultant Lane Clark & Peacock LLP. “The thought is that, if we have too many means-tested benefits, there is a disincentive for people to save.” The current proposal calls for a benefit of £140 ($218) a week, he says.

The concern about a possible savings disincentive partially explains the low U.S. minimum benefit, as does the continued issue of the American Social Security system’s viability. “In the best of all possible worlds, we would raise the minimum pension,” says Steven Sass, program director at the Center for Retirement Research at Boston College, “but first we have to make the system solvent.”

2) Adjusting the level of mandatory contributions to increase the net replacement for median-income earners: The United States does not mandate personal retirement savings, of course—although many think it would have to if it wanted to ensure adequate savings for middle-class workers. “Absent that kind of requirement, we do not see the 50% of people who are not covered by an employer plan save for retirement much,” says Arthur Noonan, a Pittsburgh-based Mercer senior consultant and actuary. Adds Knox, “What we are encouraging is broader coverage of workers.”

Australia, for example, has a mandatory “Superannuation Guarantee” savings program in which employers put aside 9% of workers’ pay for retirement. “Every worker who pays taxes participates, and that means that 85% of the population is covered by superannuation,” Ralston says.

Canada started the Canada Pension Plan in the 1960s after research found that many residents in their 60s and 70s fell below the poverty line, Ambachtsheer says. The program has a 9.9%-of-pay contribution up to $50,000 in salary, with contributions split evenly between an employer and employee. “It is mandatory participation: If you are in the workforce, you have to contribute,” he says. The result: “Middle-income workers in Canada almost replace their average workplace earnings. Today, the poverty rate for seniors in Canada is 4% or 5%.”

Sweden has a mandatory retirement-savings program that includes all workers and self-employed people—essentially, anyone earning income in Sweden, says Edward Palmer, a professor of social insurance economics at Uppsala University in Uppsala, Sweden, and a senior adviser to Sweden’s social insurance agency. Workers contribute a hefty 18.5% of their pay, including 16% to a notional defined contribution plan (NDC) that the government administers and whose investments it oversees, and 2.5% to a private account whose investments a worker chooses. About 90% of the population also has supplemental benefits from occupational schemes, he says.

Rather than starting a mandatory savings system, the U.K. has decided to implement automatic enrollment nationwide for almost all British workers, although workers have the choice to opt out. The contribution builds up gradually to a total of 8%: 4% from the individual, 3% from the employer, and 1% from the government, Scott says. The replacement ratio will vary depending on individuals’ income levels, but for lower earners, it could replace 75% of income or more, he says. “It gradually falls off as earnings increase,” he adds. The implementation timetable varies over several years based on the number of workers an employer has, but begins in 2012 at the earliest.

If the United States makes any big move in this direction, it seems more likely to resemble the U.K. than Australia or Sweden, but even that seems pretty iffy.

Asked whether the U.K. scenario could happen here, Salisbury says, “I have been at a number of public sessions with senior staff to liberal Democratic senators when it came up, and their characterization is that the U.S. Congress is not going to approve anything mandatory—period, stop. The aftereffects of health-care reform and the individual mandate essentially have taken the concept of the individual mandate and killed it.”

Knox sees a viable way to do it. “What we are really saying is, let’s have a system grow out of Social Security, to put some of it in a private-sector system and make that system mandatory,” he says. That new setup would keep some money in the current Social Security pool but also take a substantial amount of Social Security tax money and put it into accounts earmarked for specific individuals, and that money would get invested. “Everybody in the workforce would have some money set aside, partly in Social Security and partly in a 401(k) look-alike,” he says.

3) Improving the vesting of benefits for all plan members and maintaining the real value of retained benefits through to retirement: In the U.K., “anyone in a pension scheme for two years has to have the benefits preserved, and linked to inflation,” Scott says. Knox likes uniform rules that allow for quick vesting and inflation-indexed benefits. In Australia, he says, workers have immediate vesting in the compulsory superannuation program. “It is fully vested. When I leave an employer, I get it all—after day one, year one, or year five,” he says, adding that he does not argue that all countries should have immediate vesting, however.

Part of the legacy of defined benefit plans is that many defined contribution plans still favor workers who remain long term at an employer, Knox says. The current economic environment and global mobility make that practice out of whack with reality, he believes. “If we want to build up the retirement benefits of all individuals, we need to look at vesting approaches,” he says. “Let’s improve benefits for those who might leave after three or five years. Does that mean a potential restructure of the pension scheme? Yes. It means that retirement benefits will be more equitably shared, rather than favoring the guys who are there for 20 or more years.”

4) Reducing pre-retirement leakage by further limiting the access to funds before retirement: The U.K. has a much stricter stance on this than the United States. “Pensions get reasonably generous tax treatment and, in return, you basically keep the money locked up until you reach retirement age,” Scott says. Swedish workers cannot take loans or hardship withdrawals from retirement savings. “Swedes have never had that discussion,” Palmer says. “The whole idea is that you smooth your consumption over your life, and we have somehow gotten that idea into people.”

Australia does not allow loans but permits hardship withdrawals in very few circumstances, Ralston says, such as serious health problems or extreme financial circumstances in which a person has no other assets or income. “In Australia, we take preservation of income very seriously,” she says. “The whole point of having a pension system is to have money to live on when you are old.”

Many in the United States see it somewhat differently. “In the U.S. system, the idea is that Social Security is the locked-up money, and everything else is voluntary accumulation, and therefore should be subject to decisionmaking by individuals,” Salisbury explains. If anything, he adds, U.S. public policymakers face pressure to shift retirement plans to less of a pure retirement objective than a lifetime-events and lifetime-security objective.

“The issue is, once it is your money, can you use it to buy a house? Or for an education for your kids? Or if you are unemployed and you need the money to pay bills?” Sass says. “Politically, or even rationally economically, it is hard to ring-fence this money, to keep people’s hands off it.”

While stopping leakage altogether seems unlikely, Mercer’s U.S. staff already has seen some movement by employers to limit loans and hardship withdrawals. That can mean lowering the amount that a participant can take out on loan, decreasing the number of loans allowed to a participant and, in some cases, not allowing loans, Noonan says. Employers also need to increase education to help people understand the long-term ramifications of loans and hardship withdrawals on balances.

5) Introducing a requirement that part of the retirement benefit must be taken as an income stream: Swedes cannot take a lump sum from the mandatory-savings system, since the entire balance gets annuitized. That approach “works best because it guarantees everyone an adequate pension, not just a minimum pension,” Palmer says. As for letting people take the money as a lump sum and use it as they wish, he says, “The more European—and especially Northern European—idea is that there is a lot of moral hazard in doing it that way.”

Canadian retirees must take Old Age Security and Canada Pension Plan benefits as a lifetime annuity. For those who get the $8,000 OAS benefit and maximum $12,500 CPP benefit, that means CA$20,500 ($19,761) in annuity benefits annually, indexed for inflation. “That provides a base” for retirement living expenses, Ambachtsheer says. “If you double up as a couple, you are up to CA$41,000 ($39,522) without having any other pension-related income source at all.”

People need 60% to 70% of their pre-retirement income to meet basic retirement expenses, Knox says; so, given that Social Security is roughly a 40%-of-salary annuity, someone could put 20% into an income stream and take the rest as a lump sum. The report deliberately uses the term “income stream” rather than “annuity,” he says, since the latter has negative connotations for some people.

Indeed, while many countries require at least partial annuitization, Sass does not think the idea works for the United States. “When you annuitize, you pay a lot of money to make sure that next month you will get a check for $313.20. That is a contract, and it is very expensive to guarantee that,” he says. “I like longevity insurance, and maybe that is what they ought to mandate, or say, ‘We will give it to you.’ So you have got 20 years to manage your money if you retire at age 65. It is a much more manageable issue.”

Making it mandatory in the United States to take at least a partial income stream on retirement savings would face resistance, Noonan says. “Yet, in terms of solving some of the problems, it is extremely important,” he says. “As an individual, it is very hard to hedge.”